Towers Watson says that the precise impact of curbs on pensions tax relief proposed by Ed Miliband would depend on details that have not yet been spelt out. One consequence could be tax penalties for long-serving members of final salary schemes who receive significant pay rises.
In a speech on Friday, Ed Miliband announced that a Labour Government would:
• Reduce the Annual Allowance for tax-relieved pension contributions from £40,000 to £30,000.
• Reduce the Lifetime Allowance from £1.25 million to £1 million. A 55% tax charge applies to excess pension savings above this value when people draw their benefits (compared to their marginal rate of income tax at the time, typically 40%).
• Restrict tax relief on pension contributions to the basic rate for higher earners. Ed Miliband described this as applying to people earning over £150,000 but the details may be more complicated than that. This policy had already been announced.
Stephen Green, a senior consultant at Towers Watson, said:
"The impact of these changes will depend on details that weren't in Ed Miliband's speech.
"For someone earning £70,000 in a typical final salary scheme*, a £30,000 Annual Allowance would bite if they got a pay rise of at least 4% in their 30th year of service when CPI inflation was 2%. If the pay rise were 5%, they could face a tax bill of £2,336. But they might not have to pay this if a Labour Government allowed unused allowances from earlier years to be carried forward, as legislation currently permits. Long-serving members of final salary schemes, including older public sector employees who have kept a link to final salary, will hope that this facility survives. However, any carried-forward unused allowances will ultimately run out so a tax charge could arise every year thereafter if pay continues rising quickly.
"Reducing the Lifetime Allowance from £1.25 million to £1 million cuts the maximum defined benefit pension that someone can have within this ceiling from £62,500 a year to £50,000 (before taking any tax-free lump sum). For defined contribution savers, that maximum annual income will jump around with annuity rates; at current rates, it would only be around £26,000 for an inflation-linked annuity with a spouse's pension. The maximum value of tax-free cash would fall from £312,500 to £250,000.
"The Coalition has twice cut the Lifetime Allowance and on both occasions it offered protection for people whose existing savings could take them above the reduced limit. We presume that Labour would do the same but would like to see that made clear. Because there are no plans to index the Lifetime Allowance to inflation, its real value is expected to fall throughout the next Parliament in any case, but Labour's plans mean it would fall further and faster. The potential impact of a reduced Lifetime Allowance on retirement should be a real concern now for high earning members in their fifties."
Ed Miliband said that "people with incomes over £150,000 will get tax relief at 20 per cent: the same rate as basic rate taxpayers".
Stephen Green said: "This policy might be a bit more subtle than suggested today. If Labour simply cut relief on all contributions to 20% once people start earning over £150,000, a pay rise that took someone above this threshold could make them much worse off. To avoid that, the last Labour Government proposed tapering relief away, so that it only fell all the way to 20% for people with incomes above £180,000. They also planned to take employer pension contributions into account when judging whether someone had a big enough income to lose some tax relief, so that people earning £130,000 could also be caught if their employers paid £20,000 into their pension. Is that how an incoming Labour Government would implement this policy as well?
"These three measures overlap and could all be expected to change people's behaviour. Estimating how much revenue they would raise in combination is therefore very difficult. To the extent that employers change their benefits policy to pay high earners more through cash that is taxed now and less through pensions that are taxed later, short-term revenues could increase further but these immediate gains would be offset by lower tax receipts further down the road."
* Based on a pension scheme providing 1/60th of final salary for each year of service. Many members of public sector schemes who are close to retirement and who have retained a final salary link will instead be accruing 1/80th of final salary plus a lump sum of three times the annual pension. In such a scheme, the tax charge associated with a 5% pay rise above £70,000 in the 30th year of service when CPI inflation is 2% would be £768.